Updated: Sep 6
Payday loans are small and unsecured short-term cash loans that help people to get through the month until the next salary kicks. It is the small principal being lent out, but often it is lent out at a very high-interest rate(30 to 50%).
Payday loans are for those working class with difficulty making ends meet and are often broken at the end of the month. Depending on the loan provider, these loans must be repaid within 7 to 60 days. The loan's short tenure, urgent nature, and repayment risk factor make the loan very costly. The people are willing to take it just because of the convenience offered in an emergency. Payday loans in the USA are used for life events like loans for weddings, medical emergencies, and payment of school fees.
How does a Payday Loan work?
Let's see how payday loans work with an example. Let's assume you have a terrible toothache, and your dentist says you need a root canal treatment and implant. The pain is so unbearable. Your dentist quotes you $30,000. But you are still seven days away from payday, and the bank account is sadly on the verge of being empty.
You now go to one of the several online payday lenders that offers you a convenient payday loan. You expect your salary within 7 days and apply for a loan for a tenure of 7 days and the principal amount of $30,000 at 1% interest per day. So you have to pay $30,000, and $2100 adds to $32,100 after 7 days.
If you take a 30-day loan, you must pay 30% interest. If you take a 60-day loan, you will be paying 60% interest. You have to pay penalties on a per-day basis if you are late.
Advantages of Payday Loans
Payday loans are a savior for those people who live month to month and find it difficult to cater to sudden expenses.
It is Quick and Easy.
It is a fast loan that is often approved and disturbed within minutes with no hassle of waiting long.
It needs Minimum Documentation and Formalities.
In most cases, the main requirement is to have a bank account and share minimal personal and financial details. It also doesn't require any extensive documentation like other loans.
It needs no credit check.
The loans are often available to the working poor with no credit checks and collateral involved. Anyone can apply for this loan irrespective of their financial background.
Disadvantages of Payday Loans
The main reason is that payday loans are attractive and can suck the borrower into a vicious cycle of debt.
It has very High-Interest Rates:
While the interest rate per day may seem manageable, when annualized, they turn out to be 400% annual interest(APR). The APR can go up to 9000% for very short loans.
It can be a debt trap:
If you can repay the loan next month, it would result in huge penalties and additional costs. This often makes it impossible to repay going ahead and makes the probability of a debt trap very real.